KEY INVESTMENT HIGHLIGHTS

• The 4QFY19 earnings was partially subdued due to the lower contribution from the natural rubber and vinyl gloves

• Slower sales growth in developing countries as compared to the previous year

• The group has strategically align product mix with market demand by focusing on expanding nitrile gloves

• Nonetheless, we believe this will result in downward pressure on nitrile glove price

• Maintain NEUTRAL with a revised TP of

Significant dropped in sales volume of natural rubber glove. To recall, 4QFY19 earnings rose by +7.2%qoq to RM80.1m. The sequential improvement in earnings was driven by the higher sales volume (+12.0%qoq) and average selling price (+1.0%qoq) of nitrile glove. However, these were mitigated by: (i) significant dropped in sales volume of natural rubber glove (-17.9%qoq); (ii) higher natural rubber latex price (+5.0%qoq); and (iii) declining sales volume of vinyl glove (- 10.0%qoq).

Strategically aligning product mix with market demand. The strong FY19 performance of nitrile glove was attributable to the stronger sales growth in developed countries where sales volume rose by +17.0%yoy. In contrast, the subdued performance of natural rubber glove was driven by the slower sales growth in developing countries where sales volume marginally increased by +3.9%yoy. Consequently, nitrile glove has overtook natural rubber glove as the largest contributor to revenue with contribution of about 46.0% (vs FY18:40.0%) as compared to 39.0% (FY18:45.0%) for natural rubber glove. To capture the growing demand of nitrile glove, Top Glove is expected to add more than 14.2b pieces of nitrile glove production capacity per annum by the end of CY20.

New factories will improve operating efficiency. We view that the aggressive expansion in production capacity of nitrile glove will lead to pricing pressure and hence, lower profit margin. Nonetheless, we take comfort that the new factories will contribute to better productivity. Note that as of FY19, the productivity level of Top Glove’s factories was at about 2.54 workers per million pieces of gloves. These highly automated factories are expected to improve productivity level further as they are able to operate at an average of 1.84 workers per million pieces of gloves.

Impact to earnings. We revised our FY20F/FY21/FY22 downwards by -7.7%/-4.1%/-1.8% respectively as we believe: (i) there will be no meaningful recovery in sales volume for natural rubber and vinyl; and (ii) pricing pressure on nitrile glove will remain in the near term.

Target price. We tweaked our TP downward to RM4.23 (previously RM4.58) per share. Our valuation is premised on FY20 EPS of 16.9sen pegged to an unchanged PER of 25x which is the company’s three-year historical average PER.

Maintain NEUTRAL. We view that the group’s outlook will continue to be underpinned by stable and steady growth in demand of nitrile glove as health regulations become more stringent particularly in the developed markets. In response to this, Top Glove will add more than 14.2b pieces of nitrile glove production capacity per annum by the end of CY20 with total production capacity of about 40.0b pieces per annum (out of its total capacity per annum of 84.1b). By the end of this expansion plan, it will become the world’s largest nitrile glove manufacturer which serves as a competitive advantage over other major glove manufacturers. That said, we opine that the aggressive expansion in production capacity will lead to pricing pressure. In addition, the stock is currently trading at above its three-year historical average PER of 25.0x hence we believe the positivity has been priced in at current valuation. All factors considered, we maintain our NEUTRAL recommendation on the stock.

Source: MIDF Research - 7 Oct 2019